Tetra Technologies: Stock To Rise On Growth And Low Valuation

Summary

• Tetra Technologies is expected to be profitable in 2018 as the company attracts more business for key products/services.
• Conditions are positive for Tetra's businesses to thrive.
• The low valuation and strong growth will catalyze the stock for above-average gains.

Tetra Technologies (NYSE:TTI) has been turning the corner in 2018. The company experienced a rough patch due to the oil slump over the past few years. A few years of losses have turned around with profitability this year. The improvement in the oil industry will allow the company to thrive this year and beyond.

Tetra Technologies is a key player in the oil and gas industry. The company has the major oil and gas companies as their customers. The new acquisition of SwiftWater strengthened Tetra and was accretive to Tetra's earnings as of March 1, 2018.

In addition to turning profitable in terms of net income in 2018, Tetra is expected to increase ROE to over 14% in 2019 after being in negative territory in past years. Tetra's strong expected EBITDA growth in 2018 is likely to drive the stock for strong gains. The company's low valuation will help support strong stock gains going forward.

Key Businesses for the Oil and Gas Industry

Tetra has multiple businesses that operate under three divisions: Fluids, Production Testing, and Compression. The Fluids business manufactures and markets clear brine fluids and additives for use in well drilling, completion, and workover operations. This division also sells liquid and dry calcium chloride and offers water management for oil/gas companies.

I expect Tetra's fluid business to pick up this year. Tetra is seeing more activity for the fluids business in several international markets. The pickup in business for oil and gas companies means there will be more well completions. This creates greater demand for Tetra's completion fluids.

The Production Testing division handles frac flowback, well testing, and offshore rig cooling. This division is benefiting from an increase in frac activity. I expect the Production Testing division to thrive in 2018 as the oil and gas industry continues to ramp up as oil and gas prices remain strong.

Tetra has the largest fleet of production testing equipment in the industry. This equipment is designed to withstand abrasive conditions. The equipment is tested with rigorous stress tests and heat treatment to ensure that it performs optimally. The large fleet and high-quality nature of the equipment will make Tetra's production equipment sought after from their customers.

Tetra believes that the SwiftWater acquisition will make the company the largest and strongest water management and flowback testing service companies in the Permian Basin. SwiftWater is expected to add $16 million to $20 million in EBITDA on an annual basis. This is 9.5% to 11.9% of Tetra's expected EBITDA of $168 million for 2018. That will provide a nice contribution to earnings, which will help drive the stock higher.

The Compression division offers compression services/equipment for natural gas and oil operations. This division has a backlog of $47.5 million. This is about 120% higher than the backlog from a year ago of $21.6 million. The backlog is expected to be worked through in 2018. Customer demand for incremental horsepower led to utilization to rise to 92% for Tetra's larger-sized equipment with overall utilization increasing to 82.3%. The overall utilization rate was 76.4% a year ago.

Undervalued in the Oil and Gas Equipment Industry

In addition to the strong growth outlook for Tetra, the stock is trading at an attractive level. This will increase the chance for the stock to achieve above-average gains over the next year, considering Tetra's strong expected growth.

I am using the EV/EBITDA ratio to evaluate the valuation. This ratio is commonly used to compare companies in the oil and gas industry since they typically have a lot of debt. This ratio includes the cost of paying that debt off.

Tetra does have a high amount of long-term debt of $691 million as compared to $26 million in cash. However, the company is cash flow positive. So, with the industry outlook looking positive, Tetra should have no issues with paying off their debt.

Here's how Tetra compares with other companies in the Oil and Gas Equipment/Services industry:

	Tetra	Matrix (MTRX)	Schlumberger (SLB)	Archrock (AROC)	USA Compression (USAC)
EV/EBITDA	10	21	15	8	13.7

Click to enlarge

Source: finance.yahoo.com

The average EV/EBITDA ratio for all five of these companies is 13.5. Tetra is trading 26% below that average. I think this is an attractive valuation for a company that is poised to benefit from growth and improved profitability. Overall, Tetra's valuation should allow the stock to grow approximately in line with EBITDA growth.

Tetra is expected to grow revenue at 16% in 2018 (consensus). The company is also expected to grow EBITDA by 38% in 2018. That looks attainable given the improved outlook for the oil and gas industry due to a better supply/demand balance for oil. Another driver for the stock is that Tetra is expected to achieve positive net income this year after incurring losses over the past few years.

I see 16% revenue growth as reasonable for Tetra in 2018. Many of the oil majors (Tetra's customers) are expecting to grow revenue at strong double-digit rates. The higher price of oil in the $60s this year as opposed to prices in the $40s and $50s last year will help ramp up production for the oil companies, thus leading to a strong increase for Tetra's businesses.

Consensus expectations for 38% EBITDA growth this year also look reasonable. This would be about 17.6% of total revenue of $952 million. So, when the addition of $16 million to $20 million of additional EBITDA is taken out of the equation for the SwiftWater acquisition, the EBITDA would be 15% to 16% of total revenue. That is in line with what Tetra typically achieved in EBITDA in past years.

Main Risk for the Business

Tetra's business highly depends on the health of the oil and gas industry. The slump in the price of oil from 2014 into 2016 had a negative effect on the oil industry. This led Tetra to experience negative net income for the past 4 years. Another significant slump in the price of oil would likely hurt Tetra's customers leading to a decline in Tetra's business.

With that said, the outlook for Tetra's customers looks much better than the past few years. There is a better supply/demand balance for oil based on consumption and production levels. This is expected to last through 2019 according to Eia.gov. So, unless something unexpectedly changes, Tetra is set to perform well for at least the next 2 years.

Tetra's high debt is a risk for shareholders. If the oil industry experienced a slump again in the future, Tetra's balance sheet would be significantly weakened. This could lead to an equity raise, which would dilute shareholders. In the most severe case, Tetra could have trouble paying off its long-term debt when under serious financial distress. That would likely result in a sharp sell-off for the stock.

Price Target for Tetra

Since Tetra's business is tied closely to the health of the oil industry, I think it is wise to only hold the stock during bull markets for the industry. The risks that I mentioned are not likely to occur during this recovery in the oil industry. Tetra's products and services will be in demand for the foreseeable future. When the outlook for the oil industry looks bleak due to an oversupply or weak demand, that would indicate the time to sell the stock.

The recovery in the oil industry and the SwiftWater acquisition should provide Tetra with strong growth in 2018. With an attractive valuation and strong revenue and EBITDA growth expected for 2018, I see strong upside potential for Tetra's stock over the next year. My one-year price target for the stock is $5.70, for a 38% gain. Tetra's attractive valuation should allow the stock to grow approximately in line with the expected 38% EBITDA growth.

Let me know what you think of Tetra's outlook in the comment section below. Do you have any other favorite stocks in the industry?

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The article is for informational purposes only (not a solicitation to buy or sell stocks). I am not a registered investment advisor. Investors should do their own research or consult a financial advisor to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate.